JOURNALS OF ROBERT MAAS

Monday, April 16, 2007

BLOG 42

THE PENSIONS ARITHMETIC

I wanted to return to the Times’ great pensions scandal because intriguingly two of its own commentators showed dissent. David Aaronovitch questioned on the Tuesday whether Gordon Brown’s scrapping of repayable tax credits was “the main cause of the collapse of our wonderful pensions system”. He went on to say “The Pensions expert Stephen Yeo, a former advisor to David Willetts, was quoted yesterday as saying that he didn’t believe that Mr Brown’s decision was “even in the top three reasons”. Instead he blamed changes by Labour and Tory governments to pension regulations, an unexpected increase in life expectancy and unexpectedly sharp stock market falls”.

Then on Thursday, Anatole Kaletsky wrote “It is certainly true that most of Britain’s traditional private sector pension schemes have been closed to new members during Mr Brown’s tenure as Chancellor and it is also true that government policy has been largely responsible for this decline. But the claim that the 1997 “tax raid” was the main cause of these pension fund closures, or even an important contributory factor, is simply false”.

Mr Kaletsky’s reference to “traditional private sector pension schemes” being closed to new employees is not wholly correct. What has been happening is that industry has been closing final salary pension schemes and replacing them by money purchase schemes. I note from Hansard that even in 1977 Nick Gibb (leading the debate for the Conservatives) acknowledged, “I concede that a minority of pension schemes are final-salary schemes”, which hardly suggests that such schemes were “traditional”.

Personally I think that final salary schemes were a child of the sixties. They relied largely on inflation, so accordingly the real damage that Gordon Brown did to such schemes was to bring inflation under control. Well I’m sorry for the minority that got hurt, but I think that we have all benefited by low rates of inflation under Gordon Brown. I don’t think that we as taxpayers owe any obligation to pensioners whose final salary schemes collapsed as a result, except to the extent that until recently the government forced people into such schemes if the employer ran one and the employee wanted relief for his pension contributions. I think that to compensate for this it would be reasonable for the government to provide those who have lost their pensions with a pension equivalent to the annuity that would have been received had the pensions contributions made by the employee, and a matching contribution by his employer, been invested in a typical money purchase scheme instead of the actual final-salary scheme. Anything above that is the responsibility of those who egged on employees to demand unrealistic final-salary schemes that could in many cases be funded only by forcing the employer into insolvency.

I have been playing around with some figures over Easter (Yes I know that’s pretty sad!). If a person started on a salary of £20,000 40 years ago and his salary increased by say 5% pa. throughout the period he would today be earning £140,780 pa. A two-thirds pension would therefore be £93,853. At the current time a fund of £1,317,000 would be needed to produce a pension of £93,853pa. Throughout his 40 year working life the person would have earned a total of £2,439,000. If the pension fund had also increased in value by 5% pa, contributions equal to 54% of the employee’s salary would have been needed to produce the £1.317million. If it had increased in value by 8% pa. the contributions would have had to be 26% of the person’s salary.

In current conditions it is not easy to generate an investment return of 5% pa let alone 8%. Furthermore, I doubt that many employers put 26% of employees’ salaries into a pension scheme. My impression is that most contributions are in a range of 8% - 15%. Accordingly, absence inflation, the final-salary arithmetic simply does not add up.

Of course some of these assumptions are unrealistic. I doubt that many people started at a £20,000 salary 40 years ago. My salary as a Chartered Accountant in 1965 (42 years ago) when I qualified was only £1,350 per annum. Over a 40-year period, salaries do not increase evenly. They generally spurt for a time and then level off. However what this means is that the pension contributions in early years would be below average, but they are the important contributions which have generated the greatest amount of growth as they have been invested the longest.

Growth rates are not wholly dictated by inflation; they largely depend on growth in equity values, which depend on other factors, such as the popularity of a company’s product, its ability to innovate, its ability to find new markets, supply and demand, etc. Inflation can mask the problems of pedestrian businesses. But final-salary pension schemes are by definition large schemes, which often means that many innovative and high growth stock exchange investments are not available to them, as these are small companies whereas a pension fund needs to invest its money in large chunks.

So why haven’t such pension schemes gone broke earlier? An obvious reason is high stock market growth in the heady 1970’s and 1980’s. But perhaps another reason is that such funds have only started to pay out significant pensions in recent years and that their financial strength was based on assumptions that have proved not to be justified. Another reason is that many such funds penalised early leavers until the government forced transferability of pensions, so that the bulk of the benefit from contributions by such people boosted the growth of the funds for other employees. But a combination of high job mobility and statutory pension fund transferability not only means that such subsidy will not continue but also that the funds needed by the new employer to produce a two-thirds pension in less than 40 years (as many schemes offer) for a person who transfers into the scheme will be correspondingly higher.

Whatever the reason the quickening of the pace of closure of final-salary schemes to new employees seems inevitable. Indeed, the large number of prospective take-overs that are aborted because of the size of the target company’s pension fund deficit, suggests that the sooner all such pension schemes are closed the better it will be for the financial health of Great Britain plc.

The Times devoted a lot of space last week to what they termed “The Pensions Scandal”. On Monday we were told that “The Times obtained documents on Friday which showed that Mr Brown had pushed through tax changes in his first budget in 1997 despite warnings from officials that it would cost occupational and private pension funds up to £75bn and make millions of pensioners worse off”. This advice was apparently proferred on 27 May 1997. A Gordon Brown aide apparently then said that the tax change was in response to lobbying by the CBI.

This elicited a headline on Tuesday “Browne’s aide’s claim on tax grab is completely untrue, says CBI”, above an article that started “Gordon Brown has become embroiled in an unprecedented row with business leaders who effectively accused the Government yesterday of trying to lie his way out of the pensions furore”. Wednesday’s headline was “Ministers didn’t have a clue” about raid on pensions. This prefaced an article beginning “Gordon Brown made his raid on pension funds, worth £5 billion a year, without consulting other government departments, The Times has learned”.

Before it became part of News International the Times prided itself on being a paper of record, i.e. a newspaper that historians would consult in the future to discover contemporary facts. Now that it is a tabloid it seems to have adopted the tabloid philosophy of never let the facts get in the way of a good story.

So let’s start with some facts. Firstly the “tax grab on pensions” was actually part of a strategy to encourage the reinvestment of profits and discourage distributions. It was coupled with a two point cut in corporation tax, which was estimated to save businesses roughly £2bn a year – although the abolition of tax credit for companies and pension funds combined increased taxation by £3.4bn. The £5bn figure banded about appears to include the further £1.6bn raised from individuals and charities by the similar withdrawal of tax credits in the following year

Secondly, there was an extensive debate in parliament, where the effect on pension funds was acknowledged but was felt by the government to be justified by the incentive effect of the corporation tax reduction which it financed. I do not know what the Times said at the time, but the Financial Times noted at the time that “many months of energetic lobbying by the pensions industry have been ignored”, which does not suggest that the change either was unexpected or was made in ignorance of the likely effect on pension schemes. The FT also remarked that “this move on dividend tax has been progressively discounted [by the Stock Market] for several months… The overall impact is hard to judge. The big question is whether, in the global environment, dividends really matter any more. The dividend yield on the World Index is only 1.8 per cent”. This hardly suggests that Gordon Brown was ignoring warnings by officials in May 1997. He was clearly very conscious of those warnings but felt that in spite of them the encouragement towards investment was justified.

Thirdly, it is not surprising that Ministers did not have a clue about Gordon’s budget changes before budget day. The never do. Budget secrecy is extremely important. Indeed High Dalton was forced to resign as Chancellor because of injudicious comments he made to a journalist when entering the Commons chamber to make his budget speech. A Chancellor does not consult the Cabinet on his proposals; he tells other Ministers what he proposes, but normally only on the day before the budget.

I certainly doubt that the CBI lobbied for the abolition of tax credits. However they certainly lobbied for the abolition of advance corporation tax, which occurred a year later and would not have been possible without the withdrawal of tax credits. Accordingly a call for the abolition of ACT might be viewed as lobbying for the withdrawal of tax credits. No government can afford to give away money it has not collected. ACT was a means of ensuring that tax reclaimed on dividends had been paid to the Treasury in the first place. Surely the CBI were not envisaging a return to the highly complex rules that applied prior to 1965 to ensure that tax was not repaid without having previously been collected?

Accordingly, whatever the merits or otherwise of the 1997 and 1998 corporation tax reforms, what they consisted of was the abolition of repayable tax credits to enable the Chancellor to reduce corporation tax by two percentage points and to abolish ACT in response to repeated lobbying by industry about the ever-growing ACT mountain. As with all previous and subsequent Chancellors, Gordon Brown did not discuss his proposals in advance with other Ministers because of the need to preserve budget secrecy. None of that seems much of a “scandal” to me! PS. Curiously on the Friday the Times invited Gordon Brown to write a column for it, so perhaps the posturing earlier in the week was no more than good-hearted banter!

Thursday, April 05, 2007

BLOG 40

WHO ARE THE TRUSTEES?

Who are the trustees of your trust? Are you sure? Might you still be a trustee of a trust, from which you thought that you had resigned many years ago? If so, might you be liable for the acts of subsequent trustees? You almost certainly will not have sought an indemnity against such liabilities as you would not have known that it existed.

The decision of the High Court last January in Jasmine Trustees Ltd and Others v Wells & Hind and others could affect a great many trusts that were originally set up in the UK and were subsequently exported to a tax haven. The case is a professional negligence claim against two firms of solicitors and is a decision on a preliminary point only. But it is a point of general importance.

The trust in that case was created in 1968. The original trustees were Major-General and Mrs Coaker. In 1982 Major-General and Mrs Coaker appointed The Investment Bank of Ireland (IOM) Ltd (“IBI”) and a Mr Thornton to be trustees and then resigned. Or, at least, purported to resign!

Section 37(1)(c) of the Trustee Act 1925 provides that “On the appointment of a trust for the whole or any part of trust property … it shall not be obligatory, save as hereinafter provided, to appoint more than one trustee … but … a trustee shall not be discharged from his trust unless there will be either a trust corporation or at least two individuals to act as trustees to perform the trust”.

A trust corporation is defined in the Act as the Public trustee or a corporation either appointed by the court in any particular case to be a trustee, or entitled by rules made under section 4 of the Public Trustees Act 1906 to act as custodian trustee. Where a trust is exported it would be very unusual to apply to the Courts to appoint the offshore trustee, so in practice a company needs to meet the Public Trustee Act definition, which is contained in Rule 30 of the Public Trustee Rules 1912. This requires a trust corporation, amongst other things, to be incorporated in the UK or an EC Member State. An offshore company cannot meet this test. Therefore IBI is not a trust corporation – and nor is any other tax haven company likely to be one either.

The Defendant in the Jasmine Trustees case sought to claim that IBI is an “individual” for the purpose of the rules, but this was dismissed by Mr Justice Mann.

Accordingly section 37(1)(c) prohibited Major-General and Mrs Coaker from resigning. They were therefore still trustees. Major-General Coaker died in 1983 and Mr Thornton died in 1989. Mrs Coaker died in 1996. IBI resigned in 1987.

Where did this leave the trust? Answer: without any trustees. Worse, because trustees must act unanimously except where the trust deed specifies otherwise, and Mrs Coaker was not involved in any decisions made since her purported resignation, all such decisions – in particular the subsequent decisions to appoint different trustees on a number of occasions - were invalid. This meant that none of the subsequent trustees were trustees of the settlement (although they had the liabilities of trustees for having meddled with the trust assets).

It followed from this that at no time were the majority of the trustees of the settlement resident outside the UK (apart from the short period from 1983 when Major-General Coaker died to December 1987 when IBI resigned). Accordingly the trust remained throughout within the scope of UK CGT.

In journal 23 (Leave accounting to the Accountants) of 26 April last year, I was fairly scathing about the decision of the Court of Appeal in Small v Mars (UK) Ltd where I applauded the minority judgement of Lord Reed and, after noting that it was likely that the case would go to the House of Lords, ended by saying “It is to be hoped that their lordships will be convinced by the argument of Lord Reed, which is the only of the judgements that, to an accountant, accords both with the facts and with the logic of the accounting principles”.

Thankfully that is exactly what happened. The House of Lords handed down its judgement on 28 March and in a commendably short judgement, Lord Hoffman concluded, “I agree with the lucid dissenting opinion of Lord Reed”.

This is an important case for the accountancy world because it emphasises that accounting principles are constantly developing and that the Courts need to pay far more attention to the accounting principles in force at the time of a transaction than to prior Court decisions made on the basis of accounting principles that existed at an earlier time.

The case was concerned with whether or not depreciation included in stock had to be disallowed. HMRC took the approach that depreciation and other expenditure is debited in the accounts and a corresponding credit is then made to offset the debit by the introduction of the closing stock figure. This was in the face of accountancy evidence that what closing stock does is to keep the costs relating to future years out of the computation of profits.

Lord Hoffman summed the position up very well in his judgement. “Stock is an asset which has a value and cannot be a cost. But that seems to me to confuse the role of stock in a balance sheet with its role in a profit and loss account. The balance sheet is a statement of assets and liabilities on a given date and in that statement, stock is indeed one of the assets. The profit and loss account, on the other hand, is concerned with revenue and costs, and in that context, the figure for stock represents a cost which SSAP 9 requires to be kept out of the computation of profit for the year but recorded to be carried over into the computation for a future year”.